Vinod Kothari has been involved in the asset-backed securitization (ABS) market for the last five years, running training courses in 15 countries and working as a consultant. He currently acts as a securitization consultant for one of the largest global investment banks as well as holding the position as executive director of the Asian Securitization forum, and also has his own website, www.vinodkothari.com, which monitors global developments in the ABS markets.
Kothari spoke to FinanceAsia recently about the key issues facing the Asian securitization business.
FA: What do you see as the main advantages of securitization in the Asian context, over other methods of financing for example?
If we talk about Asia ex Japan, there's a significant difference between banking in Asia and in the USA. This difference also accounts for the relatively belated and slower growth of securitization in this part of the World.
Securitization is a product of larger macro changes in the world of finance such as institutionalization of savings and the moving of corporate customers away from banks over to the capital markets. One reason that explains the rapid growth of non-mortgage securitisation in the USA is the Basle Accord's regulatory norms, which has increased pressure on banks to manage their regulatory capital efficiently.
Asian banks are not as leveraged as banks in the USA, so there's no compelling reason for banks to look at off-balance sheet options. Therefore, I don't think in the Asian context it's proper to look at regulatory relief for banks as a major driver for securitisation. The major benefit one needs to emphasize here is the possibility of reducing cost of funding, whether it be in mortgage or non-mortgage markets, and avoiding asset liability mismatches.
For this reason, the way I see it, Asian securitisation for some years to come will remain centered on non-bank issuers and arbitrageurs rather than banks.
What have been the most significant market developments over the last 12 months?
In the Asian context, I believe the two most notable developments have been the kick starting of the Malaysian market with the publication of the Securities Commission's (SC) guidelines, and the increasing activity in Korea.
Other markets that also seem to be preparing themselves for securitization include Taiwan, Philippines and Indonesia.
In a global context, I'd think the most significant development has been the increased understanding of synthetic structures by both regulators and investors. One sees a larger number of synthetic securitizations in Europe and increasing interest in the USA. Synthetic structures are not triggered by off-balance sheet considerations: they're more a risk management tool, and with the growing need to shift credit risks, banks are increasingly concerned about managing their credit risk.
The other significant development is Basle's recognition of higher-rated tranches of securitized instruments as low risk investments with a 20% risk weighting. Even before BIS could finalize its norms, the FDIC and other agencies in the USA had already put similar norms in place. This will further the pace of securitization by banks to buy higher rated paper.
There is quite a lot of activity in the collateralized debt obligations (CDO) sector, which is a bit surprising given the precipitated rate of high-yield defaults.
Which do you think have been some of the best deals done in Asia in the last year?
Since there have been very few synthetic securitizations in Asia, ABN Amro's synthetic securitisation of residential mortgage loans in Hong Kong last December is certainly a notable deal. I understand that DBS Singapore is also working on a synthetic collateralized loan obligation (CLO).
There's only been one whole business securitization in Asia so far - the First Silicon deal (for a Malaysian wafer plant) structured by Nomura Securities. Nomura is noted in London as the bank that brought whole business securitization into play.
The structure is very different from a usual true-sale-based securitization and is closer to collateralized lending than securitization. However, this will act as a notable precedent for similar issues in Asia.
With the exception of Korea (and a trickle of deals in Hong Kong, Malaysia and Singapore), securitization has not really taken off in Asia. Why do you think that is?
I partly answered this when I said that Asian banks have less need for off balance sheet funding. Aside from that, a great deal of blame goes to the respective regulators who have not been very proactive in developing the right legislative framework for securitization. This is true for India, China, Philippines, Taiwan, and to an extent, even Hong Kong and Singapore.
But one also has to be optimistic: market realities move ahead of regulators. In a recent report, the Asian Development Bank highlighted the need for mortgage-backed securitisation in eight Asian countries: China, India, Indonesia, Korea, Malaysia, Pakistan, the Philippines and Thailand. I am sure the respective governments are going to listen to the ADB.
Do you think that recent moves to push for legislation in countries such as the Philippines, Taiwan and China will have any effect on developing the markets there?
Legislation is certainly an important building block for securitization. The experience of Italy, France, Portugal and several other European countries is proof of that. I would strongly recommend Asian countries to draw a lesson from Italy and incorporate similar umbrella legislation to promote securitisation.
The Italian legislation has been successful because it's all-inclusive. There are shortcomings, but it is an appreciable effort to include all relevant positions in a single law. The tax treatment is also prescribed [this has always been a murky issue in Asian ABS laws, even in Korea] and the law even covers accounting provisions.
The best proof of how the law has been a success can be seen by the fact that after it was passed, the level of activity really shot up in Italy. During the third quarter of 2001, Italian volume even exceeded the UK.
You also know a lot about securitization in India. How do you assess the current state of the market?
Some time back, a securitisation practitioner remarked that securitisation in India is like a baby waiting to be born. It has taken a very long time! There is a lot of activity in India that can be called "pseudo securitisation" but in fact it is just portfolio sales. There have been only a few capital market oriented transactions.
Until early this year, we thought the market was waiting for someone to give it a kick-start. There were some deals in the RMBS sector and stray deals in the auto finance market. But the real momentum that must come from the banking sector, non-financial sector and in arbitraging is yet to be seen.
I would have expected arbitrage CDOs to be a hit idea in India. This is where I think a lack of clarity from the Reserve Bank of India and the tax department is a stumbling block.
What exactly is an arbitrage CDO?
There are essentially two types of CDOs: balance sheet and arbitrage. Banks and financial institutions use balance sheet CDOs when they sell a portfolio of debt to lighten the balance sheet.
An arbitrage CDO is typically a vehicle where the arbitrageur, usually an asset manager, raises money by the issue of asset-backed securities and invests the same amount in a portfolio of bonds with a view to making a spread in the process. The difference between the weighted average cost of the ABS paper and the return on the assets is the arbitrage profit, which is reflected by the return on equity of the CDO.
In advanced markets, lots of arbitrage activity exists in building portfolio of junk bonds, but Asian asset managers have still not hit upon this idea. Asian bond markets are not as deep or broad as the US, but arbitrage vehicles themselves have the potential to create issuance of low rated bonds. It is a self-sustaining cycle.
To an extent, Korea has initiated what they call primary market CDOs where asset backed securities are issued for investment in primary market deals issued by small and medium sized enterprises (SMEs). It is an excellent way of supplementing the funding of SMEs and all Asian economies badly need it.
What progress is being made on an Indian securitization law?
There is a draft securitization law waiting for cabinet assent and passage by Parliament. Unfortunately over the last few months there are many other pressing matters that have kept the government busy and economic laws were not given the required priority. Hopefully, it will now see the light of the day.
Another thing of high importance will be a capital adequacy related guideline from the Reserve Bank of India.
Which other Asian countries do you see as showing the most potential for securitization and why?
China must have tremendous potential, particularly for mortgage funding. It's a known fact that lots of Chinese do not own the homes they live in. Mortgage funding is not an organized institution in China and is presently being catered to by generalized banks. In terms of mortgage funding, I think most of the Asian markets barring Hong Kong and Malaysia are ill served.
Malaysia is already showing a lot of interest since the April 2001 SC guidelines were published. Given the level of interest, there is a likely to be a buzz of activity in that region.
It is the year 2005. How far do you think the Asian securitization market will have come from its present embryonic state?
If it is embryonic now, by 2005 it must be a baby learning to run and I think it's important for young babies to learn to walk before they can run! I certainly do not see the same level of advancement as seen in the USA and Japan but we might be at par with large parts of Europe. Asians have shown in the past that they take time to catch up with an innovation, but once they do, they take it forward very fast, sometimes to the extent of surpassing it.
I am very optimistic and I think a lot of the onus lies on market participants to organize themselves as a body to lobby the regulators on required legal reforms. The Asian Securitization Forum is an attempt in that direction.